12. Whether greater co­ordination would lead
to a higher tax burden obviously depends on the effect of the
actual measures adopted both on tax rates and on tax bases. If
the elimination of "tax breaks" enables the base to
be broadened, the same total revenue could be derived from lower
tax rates. But the most significant point is that while tax decisions
remain with Member States, the wish of politicians to be re-elected
acts as a restraint. We consider that there would be a danger
of upward alignment continuing unchecked if tax decisions were
handed over to a supranational body which was not accountable
to an electorate (paragraphs 90-92).

Does the present tax system contribute to high
levels of unemployment?

13. Within their domestic tax structures, Member
States have tended to reduce taxes on income from capital, in
order to reduce capital outflow. The Commission argues that this
has caused taxes on labour to rise, which in turn has contributed
to high levels of unemployment; it concludes that measures to
increase the revenue from taxation of income from capital would
reduce unemployment. Other witnesses suggested that, although
high labour taxes could well have contributed to unemployment
in some Member States, there was insufficient evidence to show
either that the measures which the Commission was now proposing
in relation to taxes on capital income would lead to a reduction
in taxes on labour, or that even if they did this would lead to
a reduction of unemployment across the European Union. The possible
links between the distribution of the tax burden and unemployment
are complex, and we do not consider that there is firm enough
evidence to support the causal connection which the Commission
suggests. It follows that we do not agree with the Commission
that employment promotion is an argument which can be used to
support the proposed tax co-ordination measures (paragraphs 93-99).

Could tax changes be imposed on the United Kingdom?

14. We note the commitment of the Government to the
principles of national competence, subsidiarity and unanimity
in tax matters. We also note that the Government is inclined to
adopt a pragmatic view on the issue of subsidiarity when it judges
measures to be in the interests of British business; we welcome
this.

15. We recognise that the concept of national sovereignty
in tax matters is subject to market pressures. When tax bases
are highly mobile, governments may be unable to set tax rates
that differ to any great extent from the rates ruling elsewhere;
because capital is so mobile, this applies particularly to taxes
on the income from savings. The effect in practice is to reduce
the fiscal sovereignty of individual Member States. We recognise
that international co-ordination may be a way for Member States
collectively to regain some of the fiscal sovereignty which they
have lost at a national level as a result of market integration.

16. We consider that there is no case for any departure
from the principle of unanimity unless and until such a departure
has been openly and explicitly made by a change to the Treaty;
such a departure would itself require unanimous approval. We note
that this issue is likely to arise at the next IGC. We agree that
the principle of unanimity should be maintained for major issues.
But we are also agreed that that principle need not necessarily
be extended to cover all minor administrative measures dealing
with taxation, especially as the number of Member States increases.

17. We note that, like any other European Union measures,
tax proposals are the subject of negotiation. The outcome of such
bargaining may involve the pooling of sovereignty, which some
may see as a reduction of sovereignty. We do not believe that
this possible outcome should influence the Government's position
on the present tax co-ordination proposals (paragraphs 100-115).

21. We decided not to give detailed consideration
to the question of how the Code of Conduct might apply to the
United Kingdom's overseas and dependent territories, because the
House of Commons Treasury Select Committee had announced its intention
of carrying out a short enquiry into this aspect of the proposal.
We would only comment that transparency is, if anything, even
more important in the handling of matters concerning dependent
or associated territories. We hope that they have been kept fully
in touch with the Government's position. We fear that this may
not have been the case, since rumours fed by continuing uncertainty
- and alarmist, in the light of what the Minister told us - have
been allowed to remain in currency for so long (paragraphs 137-141).

22. We note that the policy controlling State aid,
which the Government accepted as part of the acquis, is
not just co-ordinated but unified, and is administered directly
by the Commission. We wonder how this chimes with the Government's
insistence on unanimity for tax measures, particularly when (at
least as far as the United Kingdom is concerned) the Code of Conduct
Group appears to be maximising the overlap with the State aid
provisions by focusing on sectoral, tightly targeted measures.
This causes us to wonder whether the Code of Conduct Group is
actually being seen as a method for identifying measures to be
tackled by the Commission under the State aid provisions, and
whether this explains the Government's apparent lack of concern
about the way in which the findings of the Code of Conduct Group
will be implemented (paragraphs 142-146).

Taxation of interest and royalty payments between
associated companies

23. This proposal provides for the abolition of taxes
collected at source on cross-border interest or royalty payments
between companies with cross-shareholdings of at least 25 per
cent. We recognise that it does not solve the fundamental problems
of multinational corporations which operate in a number of Member
States, but we consider that it would be a useful step in the
right direction. We accept the Government's position that it is
not sensible to stand on the letter of subsidiarity when the interests
of British business could be furthered by the proposal. Subject
to the results of the regulatory impact assessment being satisfactory
and to any necessary amendments of detail being made, we therefore
urge the Government to press for this proposal to be adopted as
soon as possible (paragraphs 147-150).

Taxation of income from savings (the "withholding
tax" proposal)

24. This proposal relates to the taxation of interest
paid in one Member State to individuals who are resident in another
Member State. It actually proposes not simply a withholding tax
but a so-called "co-existence model", whereby Member
States could choose either to impose a withholding tax
at source on such payments at a rate of 20 per cent, or to
provide the Member State where the recipient is resident for tax
purposes with enough information about the payments to ensure
that they can be taxed on receipt according to its legislation.
In view of the strength of opposition to this proposal, we looked
carefully at why it had aroused such controversy, taking very
extensive oral and written evidence from City representatives
and others (paragraphs 151-160).

25. Payments on which interest is not deducted at
source, and which are not reported to the tax authorities, offer
scope for tax avoidance or tax evasion. When this occurs between
EU Member States, it affects the pattern of capital flows. It
also creates inequities: if people who are unable or unwilling
to place their savings abroad pay more tax than those who do,
the revenue lost must be raised in other ways. We believe that
this must be constantly borne in mind (paragraphs 161-169).

26. Despite claims and counter-claims, we are left
with no firm evidence about the likely scale of the effect of
a withholding tax on the City of London. There is a genuine fear,
reasonably based, that its introduction would damage the City
by making Eurobonds issued from a tax haven relatively more attractive
to EU investors. We accept that there would be damage as a result
of an outflow of business. We tried to collect evidence which
would enable us to quantify the likely extent of this damage,
but such figures as were forthcoming were insufficiently substantiated
and too disparate to be convincing. We expect the long-awaited
paper which the Government is producing in conjunction with the
City to shed further light on this matter; without it we are not
able to reach a conclusion on the likely scale of the effect (paragraphs
170-175).

27. It has been argued that the additional costs
and practical problems imposed by the reporting option would have
effects just as disastrous as the imposition of the withholding
tax. But in the absence of more concrete evidence than we received,
we were not persuaded by this argument.

28. However, we have serious doubts that a co-existence
model (with some Member States adopting the withholding tax option
and others the reporting option) could work in the form currently
proposed. The problem of distributing the resulting tax revenue
is a major one, which the Commission's proposal does not address.
We are puzzled by this, and we wonder whether it results from
a wish to press all Member States into adopting the withholding
tax rather than the alternative route; if so, we would regard
it as disingenuous. We agree with the Government that, if any
change is to be made, the adoption of the reporting option on
an EU-wide basis would be preferable to the imposition of a withholding
tax.

29. Considering whether this would be a practicable
way forward, we find it difficult to accept that the insistence
of a few Member States on maintaining bank secrecy should force
others to adopt a manifestly unsatisfactory solution to the problem
of evasion which undoubtedly exists. We were surprised that HM
Treasury had needed time to assemble information on banking secrecy
in other Member States; we would have thought that the Government
would already have this information to hand to formulate its negotiating
position on the Directive (and indeed that the Commission would
have analysed it as part of the process of considering how to
deal with evasion). But we were encouraged to hear the Paymaster
General's claim that the German Governmentpreviously one
of the main proponents of bank secrecynow accepted that
exchange of information was the best way forward (paragraphs 176-186).

30. In relation to the short term effects if the
proposal were to go ahead, we note the view that problems arising
from private sector contracts, voluntarily assumed, should not
be allowed to affect public policy decisions. Nevertheless, we
can see that there is an argument for the adoption of a "grandfathering"
arrangement (allowing interest on existing Eurobonds to continue
to be paid gross) to avoid massive disruption of the market.

31. Looking at the longer term effects of the proposal,
we note that the OECD is seeking a solution on a broader basis
than simply the European Union, but we cannot see what small tax-haven
countries outside the EU would gain from taking part in such an
arrangement. It follows that if the proposal were adopted the
danger of driving the Eurobond market out of the City of London
- and indeed out of the European Union - would remain. We agree
that this potential cost exists, and that the benefits from the
Directive to set against those costs might be limited, but we
have no basis on which to quantify either.

32. We have not therefore been able to reach agreement
on the best way forward. It is argued in some quarters that there
are no feasible amendments to the proposal which might make it
acceptable, and that unless the proposal is withdrawn the United
Kingdom should use its veto, even though this could mean paying
a price in negotiating terms. Another view is that it may be possible
to find an acceptable version of the proposal, either by making
appropriate exemptions from the withholding tax (to limit damage
to the Eurobond market, and hence to the City of London), or by
ensuring that Member States choosing the reporting option do not
thereby lose revenue. Without access to the evidence about the
likely scale of impact on the City which the Government has been
collecting for the past year, we have no basis on which to reach
a conclusion on this proposal (paragraphs 187-199).

38. In general, we have no objection to proposals
tidying up VAT arrangements, provided there are no significant
new administrative burdens. Nor would we be concerned if proposals
relating purely to the administration of VAT were adopted by qualified
majority voting, or provided for subsequent decisions to be taken
by qualified majority voting (paragraph 216).

Energy taxation

39. We decided that to cover the proposal for the
taxation of energy products would make our enquiry unmanageably
broad, not least because the issues on energy taxation are as
much environmental as financial (paragraphs
217-218).

Excise duties

40. No acceptable proposalsor even principleshave
yet been put forward in respect to excise duties. We share the
Government's regret at this situation, but because of it we have
not considered excise duties in the course of this enquiry (paragraphs
219-220).